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Neil Woodford 1 September 2014 Est. reading: 3 min read

“When my information changes, I alter my conclusions. What do you do, sir?”
John Maynard Keynes

Until last year, I hadn’t owned a bank in my portfolios since 2002 but I have always kept a close eye on the sector. I have had several meetings with the management of the UK-listed banks during this time but have remained concerned about the quality of loan books, capital adequacy and high leverage ratios. I continue to believe that the process of post-crisis balance sheet repair still has a long way to go, particularly for the UK-focused high street banks.

HSBC is a very different beast, however. It is a conservatively-managed, well-capitalised business with a good spread of international assets. As Chief Executive, Stuart Gulliver has done a great job over the last four years, making a very complicated organisation much simpler to understand. It is still a huge and complex business, however – its 2013 Annual Report & Accounts document runs to around 600 pages, many of which are dedicated to the risks that it faces.

It is a challenged business in a troubled sector, but it has navigated through the headwinds that have blighted the banking industry in recent years robustly. I have questioned its valuation at times both pre and post financial crisis. But over the past couple of years it has returned to a more attractive valuation level, regularly trading at around or even below its book value and its yield is also appealing.

I started to build a position in HSBC for some portfolios in May last year and I included it in the portfolio of the CF Woodford Equity Income Fund at launch. In recent weeks, however, I have started to become more concerned about one particular risk: that of “fine inflation” in the banking industry. Clearly, banks have attracted many fines in the post-financial crisis world as regulators and policy-makers have cracked down on past and ongoing wrongdoings in the industry. The size of the fines, however, appears to be increasing.

For example, in 2012, HSBC was fined $1.9bn for failing to prevent Mexican drug cartels laundering money through its bank accounts. Last month, Bank of America agreed to pay $16.7bn to end investigations into its role in the run up to the financial crisis, selling toxic mortgages. This would represent the largest single federal settlement in the history of corporate America.

Clearly, in both instances, these are wrongdoings which would be expected to incur a substantial fine. I am concerned, however, that these fines are increasingly being sized on a bank’s ability to pay, rather than on the extent of the transgression. In particular, I am worried that the ongoing investigation into the historic manipulation of Libor and foreign exchange markets could expose HSBC to significant financial penalties. Not only are these potentially serious offences in the eyes of the regulator, but HSBC is very able to pay a substantial fine.

The size of any potential fine is unquantifiable, so this represents an unquantifiable risk. Nevertheless, a substantial fine could hamper HSBC’s ability to grow its dividend, in my view. I have therefore sold the fund’s position in HSBC, reinvesting the proceeds into parts of the portfolio in which I have greater conviction.

Sometimes, the evolution of an investment case can be subtle but significant enough to represent a change in investment view. I’m not suggesting that HSBC is a bad investment but in the light of this growing risk, I now view the shares as broadly fair value. By contrast, there are plenty of stocks I can invest in which look significantly below fair value – AstraZeneca, BAe Systems, Drax, Legal & General to name a few of the positions that have been recently increased – and I believe the long-term interests of my investors will be better served by focusing the portfolio towards them.

What are the risks?

  • The value of the fund and any income from it may go down as well as up, so you may get back less than you invested
  • Past performance cannot be relied upon as a guide to future performance
  • The ongoing charges figure is charged to capital, so the income of the fund may be higher but capital growth may be restricted or capital may be eroded
  • The fund may invest in other transferable securities, money market instruments, warrants, collective investment schemes and deposits – some of these security types could increase the fund′s volatility and increase the level of indirect charges to which the fund is exposed
  • The fund may invest in overseas securities and be exposed to currencies other than pound sterling – as a result, exchange rate movements may cause the sterling value of investments to decrease or increase
  • The fund may invest in unquoted securities, which may be less liquid and more difficult to value, because they are generally not publicly traded – the lack of an open market may also make it more difficult to establish fair value

Important information

Before investing, you should read the Key Investor Information Document (KIID) for the fund, and the Prospectus which, along with our terms and conditions, can be obtained from the downloads page or from our registered office. If you have a financial adviser, you should seek their advice before investing. Woodford Investment Management Ltd is not authorised to provide investment advice.

The Woodford Funds (Ireland) ICAV (the “Fund”) has appointed as Swiss Representative Oligo Swiss Fund Services SA, Av. Villamont 17, 1005 Lausanne, Switzerland. The Fund′s Swiss paying agent is Neue Helvetische Bank AG. All fund documentation including, Prospectus, Key Investor Information Documents, Instrument of Incorporation and financial reports may be obtained free of charge from the Swiss Representative in Lausanne. The place of performance and jurisdiction for all shares distributed in or from Switzerland is at the registered office of the Swiss Representative. Fund prices can be found at www.fundinfo.com.

Woodford Investment Management Ltd is authorised and regulated by the Financial Conduct Authority (firm reference number 745433). Incorporated in England and Wales, company number 10118169. Registered address 9400 Garsington Road, Oxford OX4 2HN.

Woodford Patient Capital Trust plc is incorporated in England and Wales, company number 09405653. Registered as an investment company under section 833 of the Companies Act 2006. Registered address Beaufort House, 51 New North Road, Exeter, EX4 4EP.

© 2019 Woodford Investment Management Ltd.
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